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Sunday, September 28, 2008

What are your future options?

A British schoolboy cricketer had once approached Sir Geoff Boycott to learn how to play the hook shot, because he was frequently getting out trying to hit a hook. Boycott told him that the best way to play the hook shot was not to play it! "But how do I score runs?", the boy had asked. Boycott's response was typical: "Don't get out! The runs will come."

Futures and options trading by small investors is akin to a school boy playing the hook shot. The chances of losing money overshadows the probability of scoring big. It is far better to buy quality stocks and wait for your wealth to grow.

Nowadays the lot sizes for F&O trading have been reduced, but the risks have not. Such trading is better left to professional and institutional investors who play for much bigger stakes and usually buy or sell in the cash market and hedge in the futures.

There is no harm in being aware of what F&O trading is all about, and some smart investors can get clues about the market from the difference in spot and future prices and volumes. But I get  confused when I hear talk about 'covered calls',  'strangles' and 'naked futures' and have stayed far away from F&O trading.

Seems like I'm not in a minority of one. The legendary Peter Lynch has made the following comments in his book 'One Up on Wall Street':

"I've never bought a future nor an option in my entire investing career.... Reports out of Chicago and New York, the twin capitals of futures and options, suggest that between 80 and 95% of the amateur players lose. Those odds are worse than the worst odds at the casino or at the race track, and yet the fiction persists that these are 'sensible investment alternatives'.... I know that the large potential return is attractive to small investors who are dissatisfied with getting rich slow. Instead they opt for getting poor quick .... Warren Buffet thinks that stock futures and options ought to be outlawed, and I agree with him."


Nikesh Goyal said...

The only blog in my life I sucked in 30 minutes............ Please keep it continued...

Subhankar said...

Thanks Nikesh. The stock market has taught me a lot in the past 20 years - the most important lessons I learned were being patient and being humble. The blog is my endeavor to pass on some of my experiences as a lay investor to the investor community at large.

S.Sujai Gangatharan said...

Dear Mr.Ghose

Nice to read ur posts, keep continue.


Subhankar said...

Thanks Sujai. As long as there are appreciative readers like you and Nikesh, I'll try and keep up my weekly posts.

Eswar Santhosh said...

You should have tried a Delta Neutral Options portfolio or an Iron Butterfly Spread. That would have properly taught you to "hook" :)

If it has not been for this over-leveraged traders, would we get lower circuits at all? They perform a very useful role in the market, though they are self-less and are here to help investors and "investors" hunt for bargains. Such help should be appreciated. If nobody is speculating, would you get a chance to sell higher and buy lower? :)

Subhankar said...

Forget about hooking - you've completely shattered my stumps with your options and spreads, Eswar.

Iron Butterfly brought back tons of nostalgia. You must not have heard their 17 minutes track "In-a-gada-da-vida" from 1968. A little before your time, I suppose.;-)

SG Money Mind said...

The futures and options are not entirely bad. But the way some small time investor uses it makes it a dangerous weapon. The 'naked' usage makes it a weapon instead of a tool.

Instead of outlawing these instruments altogether, alternative ideas to restrict the usage may be better a option. That would restrict it for the genuine usage.

As for Buffet, he uses these instruments to his advantage. Have a look at the page 16 of BH's 2007 AR.

As for me, I still find it difficult to understand on how to use it properly and hence have avoided it until now. Quite happy with my strategy.

Subhankar said...

I'm sure some investors may find F&O a useful strategy - particularly institutional investors and HNIs. But I just don't like the odds for success that Peter Lynch has mentioned.